When you pay tax in your ISA and SIPP /

Al­though tax-ef­fi­cient these ve­hi­cles do not en­able you to avoid HMRC’s grasp en­tirely


Peo­ple putting their money away into an ISA or SIPP can shel­ter their sav­ings from tax, but you’d be mis­taken for think­ing that all as­pects of these ac­counts are en­tirely tax free.

Here we ex­plain the sit­u­a­tions where you would end up pay­ing tax on this money – from in­her­i­tance tax to be­ing pe­nalised for sav­ing too much.


Money put into an ISA ac­count can grow free of tax, mean­ing that you pay no in­come tax or cap­i­tal gains tax on the re­turns. When you with­draw the money from the ac­count there is also no tax due.

With a pen­sion or SIPP you get Gov­ern­ment tax re­lief on the money you put in, pro­por­tion­ate with your in­come tax level. This means that your con­tri­bu­tions are tax free. Any gains within the pen­sion are also tax free, and you then pay tax on the lump sum or in­come you draw from it, at your mar­ginal rate.


De­spite the above, ISAs and pen­sions are not en­tirely tax free. There are cer­tain sit­u­a­tions where you will pay tax.

First, most peo­ple pay stamp duty when they buy cer­tain shares. This is usu­ally a tax of 0.5% of the value of the trans­ac­tion when you buy shares. You pay this money au­to­mat­i­cally if you buy the shares elec­tron­i­cally.

This doesn’t ap­ply if you buy units of an open-ended in­vest­ment com­pany, also known as an OEIC, or buy units in a unit trust from a fund man­ager. How­ever, the fund man­agers in the funds you buy will have to pay this tax, so you’ll pay for it in­di­rectly.

An­other area where you may pay tax within an ISA is on div­i­dends paid out by any for­eign com­pa­nies that you own in your ISA or pen­sion. This would only arise if you own shares in a com­pany based over­seas, and it doesn’t ap­ply to all coun­tries. This tax is known as a ‘with­hold­ing tax’ and the rate you pay de­pends on the coun­try.

You can usu­ally claim this money back, but it can in­volve a lot of pa­per­work and in­for­ma­tion be­ing filed with for­eign tax au­thor­i­ties. The UK has ne­go­ti­ated a dou­ble tax­a­tion agree­ment with some coun­tries, mean­ing you are ex­empt from pay­ing the ad­di­tional tax in some places.

In­her­i­tance tax poses the big­gest threat to your ISA pot, as ISAs are con­sid­ered part of your es­tate for in­her­i­tance tax pur­poses. Ev­ery­one can have £325,000 of as­sets be­fore they have to pay in­her­i­tance tax, but any­thing above this amount will be taxed at 40%.

While this seems like a large limit, property is counted as part of your es­tate, so any­one with a higher-value home (par­tic­u­larly

if they live in Lon­don and the south-east where property prices are higher) and a healthy in­vest­ment pot may hit this limit.

The only ex­emp­tion to this is if you in­vest in cer­tain shares listed on the AIM stock mar­ket within your ISA. Some of these com­pa­nies are eli­gi­ble for some­thing called Busi­ness Property Re­lief. This means that as long as you hold the shares di­rectly and for at least two years, they will be ex­empt from in­her­i­tance tax.

How­ever, these com­pa­nies are smaller and so tend to be a riskier in­vest­ment, mean­ing you may not want to put a large por­tion of your pen­sion or longterm sav­ings in these com­pa­nies.


With pen­sions, you face spe­cific taxes if you save too much in your pen­sion, either each year or over your life­time.

Pen­sions have an an­nual limit on con­tri­bu­tions, which is £40,000 for the ma­jor­ity of peo­ple. It’s lim­ited to £10,000 for some higher earn­ers, in what is known as the ‘ta­pered an­nual al­lowance’. Any­thing you save over your limit each year is not eli­gi­ble for tax re­lief, in the same way as the rest of your con­tri­bu­tions are.

Once you’ve taken ad­van­tage of the pen­sion free­doms you’ll also find the amount you can save into de­fined con­tri­bu­tion pen­sions, like SIPPs, is re­duced to £4,000.

Pen­sions also have a life­time al­lowance, plac­ing a cap on how much you can save up into your to­tal pen­sion pot. The limit for the cur­rent tax year is £1.03 mil­lion, but this limit is not just on the con­tri­bu­tions you make to your pen­sion over your life­time – it in­cludes the tax re­lief you get from the Gov­ern­ment and all the in­vest­ment growth on your pen­sion.

The value of your pot for the pur­poses of the life­time al­lowance will be de­ter­mined either at age 75 or when you take money from your pen­sion. The tax rate you’ll pay de­pends on how you use your pen­sion money: it’s a 55% tax charge if you take a lump sum from your pen­sion or 25% if you take an in­come from it. Clearly this can add up.

In­her­i­tance tax poses the big­gest threat to your ISA pot, as ISAs are con­sid­ered part of your es­tate for in­her­i­tance tax pur­poses

Laura Suter, per­sonal fi­nance an­a­lyst, AJ Bell

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